Foreign Currency Transactions

FOREIGN
CURRENCY
TRANSACTIONS
FOREIGN CURRENCY TRANSACTIONS
FOREX TRANSACTIONS IN GENERAL
In a strict sense, foreign exchange transactions are

those that are to be settled in foreign currency,
regardless of the location of either party. These
are accounted for by the domestic company by
translating the amounts in foreign currency with
BSP-set exchange rates
FOREX TRANSACTIONS IN GENERAL
For translation purposes, the exchange rates must be

quoted directly, where the Peso is expressed as the
equivalent of one foreign currency.
Rates displayed on news are usually on indirect
quotation. To convert, 1 ÷ (FC equivalent of Php 1).
Converting from direct quotation to indirect quotation
also follows the same format
If the given exchange rates in a particular problem are
not in Peso, conversion is necessary
IMPORT AND EXPORT
(UNHEDGED)TRANSACTIONS
In an unhedged import and export transaction, the
only relevant exchange rate would be the spot rate as
of the date of the transaction, balance sheet date, and
the date of settlement
IMPORT AND EXPORT
In an unhedged import and export transaction, the
only relevant exchange rate would be the spot rate as
of the date of the transaction, balance sheet date, and
the date of settlement
IMPORT AND EXPORT
Spot rates are classified as either buying or selling
(also called bid and offer rates, respectively). If the
domestic entity exports, the buying rate is used since
this would be the price that the foreign buyer would
pay for the goods. If the domestic entity imports, the
selling rate is used.
IMPORT AND EXPORT
Suppose the domestic company exports goods on
F.O.B. destination freight terms. On the date of
transaction, the spot rate to be used will be as of the
date when the goods reached the buyer the point when
legal title is passed under the freight term. Of course,
if on F.O.B. shipping point, it will be when shipped
IMPORT AND EXPORT
The domestic entity recognizes forex gains or losses as
the spot rate changes during the aforementioned dates
only. For instance, if the domestic entity is an exporter
(thus it has outstanding accounts receivable) and the
buying spot rate increases, the entity recognizes forex
gains to be recorded in profit/loss (together with an
increase in accounts receivable)
IMPORT AND EXPORT
The foreign entity does not record any forex gains or
losses since the transaction is denominated in their
currency
The final cash payment during the date of settlement
shall of course still be at the spot rate, so is the cost
at which the asset purchased is recorded
FOREIGN DEBT TRANSACTIONS
• Just like purchase of commodities, forex gains/losses

are also recognized in foreign debt
borrowings/grants. Also, the purchase of the goods
might have been made through issuance of
promissory notes and other debt instrument
• If the domestic entity is a borrower, it must use the

selling spot rate, and the buying spot rate if it lends
• ILLUSTRATION - Pa Rong Co. signed a two-year
promissory note bearing 12% on December 1, 2016
for $10,000. Interest is to be paid monthly. Assume
the selling spot rates are the following: Php 2
(December 1), Php 3 (December 31), and Php 1.5
(December 31, 2017)
• ILLUSTRATION - Pa Rong Co. signed a two-year
promissory note bearing 12% on December 1, 2016
for $10,000. Interest is to be paid monthly. Assume
the selling spot rates are the following: Php 2
(December 1), Php 3 (December 31), and Php 1.5
(December 31, 2017)
On December 31, 2016, any forex gains/losses on
the loan is based on the principal alone. Thus, there is
a forex loss of Php 10,000 with a credit to Notes
Payable for 2016 ($10,000 × [Php 3 – Php 2])
The actual interest expense is based on the current
spot rate of the principal amount
On December 31, 2017, forex gains/losses are now
based on both the principal and the interest. The forex
gains/losses from the interest is based on the forex
gains/losses computed on the principal. There is a
forex gain on the principal amounting to Php 15,000
($10,000 × [Php 3 – Php 1.5]). Thus, there is also a
forex gain on the interest, amounting to Php 1,800
(Php 15,000 × .12)
FIRM (PURCHASE/SALE) COMMITMENTS
There is no actual transaction taking place in a firm
commitment, which can be to sell or purchase
something at a future date. This means that the
purchase/the asset is not recorded until the date of
settlement, unlike the previous transaction in which the
asset is already recognized at the date of transaction.
Only a memo entry is made for the asset during the
transaction date
• Only forward rates are relevant in this case. At the
date of settlement, the purchase is recorded using the
forward rate at the date of settlement. In a firm
commitment, the buyer (or seller) contracts that he
will pay (receive) an amount at the agreed rate no
matter if it changes
• There is zero net forex gain/loss in a firm commitment.

Suppose the domestic entity enters in a purchase
commitment, and that the forward rate increases. They
would record a forex gain on the commitment (debit
Accounts Payable, credit Forex Gain) and a forex loss on
the item (debit Firm Commitment, credit Forex Loss) at
the same amount. ‘Firm Commitment’ in this case is an
asset account
At the date of settlement, the domestic entity

pays/receives an amount equal to the forward rate at
the date of settlement. The cost of the asset, as
mentioned, is at the forward rate at the date of
transaction. Any difference is debited/credited to Firm
Commitment account
HEDGED FOREX TRANSACTIONS:
GENERAL CONCEPTS
• Entities engage in hedging transactions to mitigate
potential losses arising from volatile exchange rates.
To hedge is to take the position opposite that of the
transaction. This means that if the hedged item (the
asset) records a forex gain, the hedge records a forex
loss to even out things
HEDGED FOREX TRANSACTIONS: GENERAL
CONCEPTS
Hedging instruments are usually in the form of derivatives,

financial instruments that derive their value from another
instrument. They are classified as either option-based (offers
one-sided protection against exchange rate risks, such as
options and swaps) and forward based (offers two-sided
protection, such as forward and futures contracts)
CONCEPTS
Just like in a firm commitment, there are two sets of entries
to be made in a hedged transaction – one for the hedged
item (the asset) and one for the hedging instrument.
Suppose that the domestic entity sells, and the exchange rate
increases. The hedged item would record a forex gain (debit
Accounts Receivable, credit Forex Gain), and the hedging
instrument would record a forex loss (debit Forex Loss,
credit Forward Contract Payable)
GENERAL CONCEPTS
• The net forex gain/loss from the hedged item and

hedging instrument is referred to as the forex
gain/loss from hedging activity
CONCEPTS
Of course, on the hedging instrument’s side, the Forward

Contract Receivable account absorbs any change in
exchange rate if the domestic entity purchases, and Forward
Contract Payable if it sells. On the other side, Accounts
Payable and Accounts Receivable absorbs the
changes, respectively
CONCEPTS
Of course, on the hedging instrument’s side, the Forward

Contract Receivable account absorbs any change in
exchange rate if the domestic entity purchases, and Forward
Contract Payable if it sells. On the other side, Accounts
Payable and Accounts Receivable absorbs the
changes, respectively
GENERAL CONCEPTS
• Note that the liability/receivable to third person is

based on the entries on the hedged item, not the
hedging instrument
GENERAL CONCEPTS
Forward rates are used for the hedging instrument until
the date of settlement, when the spot rate is used. Of
course, if the selling spot rate is used on the hedged
item, the selling forward rate is used for the hedging
instrument
GENERAL CONCEPTS
• Problems usually present forward rates classified as

per a particular number of days. The rate to be used
is the number of days remaining until the date of
settlement
GENERAL CONCEPTS
• Problems usually present forward rates classified as

per a particular number of days. The rate to be used
is the number of days remaining until the date of
settlement
CONCEPTS
• On settlement date, the domestic entity either receives
(debits) or pays (credits) cash equal to the difference of
the spot rate at settlement and the forward rate at the date
of transaction. This is because the agreed upon rate (the
forward rate at the date of transaction) is the amount that
the parties agreed to be paid regardless of the change in
the rates. A bank or other speculators usually handle the
difference
HEDGED FOREX TRANSACTIONS: ACCOUNTING FOR
HEDGING INSTRUMENTS
Hedging instruments are also classified as either fair value

hedges (used in transactions with recognized assets and
liabilities, such as in actual purchases/sales), cash flow
hedges (used in forecasted and anticipated transactions), and
net investment hedges (similar in treatment as to cash flow
hedges, used between a domestic and a foreign entity)
HEDGING INSTRUMENTS
If silent, the hedge is assumed to be one of fair

value hedge
HEDGING INSTRUMENTS
Recording exchange rate changes as they affect the

hedging instrument can be made in two ways – split
and non-split accounting. Under split accounting,
gains/losses of the instrument is divided into the
effective portion (or the intrinsic value), and the
ineffective portion (or the time value gains and losses)
HEDGING INSTRUMENTS
Recording exchange rate changes as they affect the

hedging instrument can be made in two ways – split
and non-split accounting. Under split accounting,
gains/losses of the instrument is divided into the
effective portion (or the intrinsic value), and the
ineffective portion (or the time value gains and losses)
HEDGING INSTRUMENTS
In fair value hedges, both the effective and ineffective

portion of the gains/losses go to profit/loss. In cash
flow/net investment Hedges, the effective portion is a
component of other comprehensive income, while the
ineffective portion goes to profit/loss
HEDGING INSTRUMENTS
In fair value hedges, both the effective and ineffective

portion of the gains/losses go to profit/loss. In cash
flow/net investment Hedges, the effective portion is a
component of other comprehensive income, while the
ineffective portion goes to profit/loss
HEDGING INSTRUMENTS
Split and non-split accounting is best illustrated with

options
HEDGING INSTRUMENTS
Split and non-split accounting is best illustrated with

options
HEDGED FOREX TRANSACTIONS :OPTION CONTRACTS
Options are contracts that grant holders the right to

either buy (call) or sell (put) goods at the future date at
a predetermined price, called the strike/exercise price.
This is recorded as an investment in the balance sheet.
The amount paid for an option is referred to as the
option premium
Options are contracts that grant holders the right to

either buy (call) or sell (put) goods at the future date at
a predetermined price, called the strike/exercise price.
This is recorded as an investment in the balance sheet.
The amount paid for an option is referred to as the
option premium
They may be classified as to the likeability of their exercise. If the

option is at the money (strike price equals current market prices),
the option is likely to be exercised, bearing no loss on the holder.
If the option is in the money, it is also likely to be exercised,
bearing gains on the holder. In a put option, this is when the strike
price is greater than market prices; in a call option, this is when the
strike price is less than market prices. If out of the money, the
option is likely not to be exercised, since it would bring losses to
the holder
The option contact is the hedging instrument. However, it is

not a derivative like forward contracts, since it has its own cost
(the option premium). Also, it is not affected by changes in
the forward rate, since its value depends on its current fair
value.
The change in the fair value is total gains/losses on the hedging

instrument, to be recorded on profit/loss (if fair value hedge) or other
comprehensive income (if cash flow hedge) if the company uses non-
split accounting.
If problems mention that “the effect of time value gains/losses are

excluded in the assessment of hedge effectiveness”, the company
uses split accounting, wherein the fair value change is divided into the
effective and ineffective portions. Option contracts are usually classified
as cash flow hedges
• The intrinsic value is computed by multiplying the notional amount

(the amount of the foreign currency) by the difference of the strike
price and the market price per item. The change in the intrinsic value
is the effective portion of the total gains/losses. Note that the
intrinsic value itself is not the effective portion to be sent to OCI.
The same goes for the time value gains/losses
• There is only intrinsic value if the option is in the money, otherwise it

shall be zero. At the settlement date, the intrinsic value should always
match the fair value of the option, resulting to a zero time value
gains/losses
The effective portion is among the components of OCI that gets

transferred to profit/loss. The amount is transferred if the asset
purchased is sold or depreciated, whichever is applicable
The effective portion is among the components of OCI that gets

transferred to profit/loss. The amount is transferred if the asset
purchased is sold or depreciated, whichever is applicable
• The forex gain/loss from the hedging activity in this case is equal
only to the time value gains/losses, since the effective portion goes to
other comprehensive income

Foreign Currency Transactions

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FOREIGN

In a strict sense, foreign exchange transactions are

For translation purposes, the exchange rates must be

• Just like purchase of commodities, forex gains/losses

• If the domestic entity is a borrower, it must use the

• There is zero net forex gain/loss in a firm commitment.

At the date of settlement, the domestic entity

Hedging instruments are usually in the form of derivatives,

• The net forex gain/loss from the hedged item and

Of course, on the hedging instrument’s side, the Forward

Of course, on the hedging instrument’s side, the Forward

• Note that the liability/receivable to third person is

• Problems usually present forward rates classified as

• Problems usually present forward rates classified as

Hedging instruments are also classified as either fair value

If silent, the hedge is assumed to be one of fair

Recording exchange rate changes as they affect the

Recording exchange rate changes as they affect the

In fair value hedges, both the effective and ineffective

In fair value hedges, both the effective and ineffective

Split and non-split accounting is best illustrated with

Split and non-split accounting is best illustrated with

Options are contracts that grant holders the right to

Options are contracts that grant holders the right to

They may be classified as to the likeability of their exercise. If the

The option contact is the hedging instrument. However, it is

The change in the fair value is total gains/losses on the hedging

If problems mention that “the effect of time value gains/losses are

• The intrinsic value is computed by multiplying the notional amount

• There is only intrinsic value if the option is in the money, otherwise it

The effective portion is among the components of OCI that gets

The effective portion is among the components of OCI that gets

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